Save by using your new asset as security for the loan
“Just show me the money.” Unfortunately, that’s the approach of too many small business owners. Perhaps in the past they have experienced difficulty in obtaining a loan, and so when just anything becomes available, they grab it. Even with too high of a price tag. In actual fact, it is very easy for most businesses to finance the purchase of an asset, using it as security. And when they do it that way, they get a lower interest rate with most lenders. Any piece of machinery, vehicle or item of equipment can normally be financed this way, as long as it can be identified with a serial number.
Types of Asset Finance
It makes little difference to the lender as to what type of finance you get for your purchase. Have a chat with your accountants, because it probably will make a difference to the strategy that they have set up for you.
A chattel mortgage is the simplest loan for asset finance, and the most common. The term “chattel” means that it’s not real property that is being used as security, and “mortgage” indicates that you wouldn’t be allowed to sell the item without the permission of the lender, while there is money owing on it.
Typically, the entire cost of the purchase is financed, with regular repayments being made through the life of the loan. The interest might be either fixed or variable, and you may have a choice between the two. At the end of the loan term, there can be a final “balloon” repayment. If there is one, you try to target the resale value of the item at that time.
The loan term should be comparable to the life of the asset. So, if you are getting a loan for a new ute, you might have five year loan, and target replacing the vehicle at that time. If it’s a computer, you would probably want to pay it off fully in a couple of years.
The main difference between a chattel mortgage and a lease is asset ownership. If you lease the item, it remains owned by the company providing the lease through the term of the lease. Most likely you would have the option of purchasing the item at the end of the lease for the equivalent of what would be the balloon payment with the chattel mortgage.
This difference basically comes down to taxation, and that’s why your accountant is involved. If you have the chattel mortgage, the interest should be a tax deduction along with the depreciation of the vehicle or piece of equipment. Repayments of principal are not tax deductible. However, with the lease, the entire lease payment is an expense, and therefore should be tax deductible. But, because you do not own the item, nothing is deductible for depreciation.*
By the way, this is very similar to a “hire purchase,” which was quite popular years ago, but less so today. You hire the item over a period of time and then have the obligation to purchase it for an agreed price (the balloon payment amount) at that time.
Unsecured business loan
Generally, we do not recommend them, due to the high interest rates, but there are those times where cash is needed upfront for something that is going to generate a huge return, and it becomes worthwhile when other methods of finance are not available.
For this type of loan, they are generally only suitable, and available, for short term loan terms, often 12 months. A common scenario is for the purchase of stock, which will then soon be sold, a portion of the proceeds being used to repay the loan.
The lender will be looking closely at your credit rating and business turnover. Owing money to the ATO beyond the norm could be an issue.
Sometimes a business owner may think that they will simply go out and get an ordinary personal loan. But such loans cannot be used for business purposes, so count that out.
Asset Finance FAQs
How much can I borrow?
The number one most asked question, with an answer that’s different for each person. Because it's all depending on what your income is and the value of the property(ies) that you have to use as a security for the loan. (See the answers for "Serviceability" and "LVR" below)
What is a "LVR"?
LVR stands for "Loan to Value Ratio." It’s calculated by dividing the loan amount by the value of the securities involved. Lenders limit the amount you can borrow according to this LVR rule. Generally, most people can borrow up to 80% LVR (that’s 80% of the value of the property) without penalty. In some cases, by paying for "Lenders Mortgage Insurance" (See "LMI" below) up to 95% can be borrowed, or even 97% where the cost of the LMI becomes included within the loan amount ("capitalised LMI").
What is "serviceability"?
Your ability to generate enough income to cover loan payments is described as "serviceability." Each bank has its own way of calculating how much income you need. The interest rate will be higher than present rates in the calculation to allow for rates going up in the future causing undue stress on your financial situation. Credit cards and loans not being refinanced will have payment amounts increased to cover the amount owing as if the facility was fully drawn. That means that if you have a credit card with a very large credit limit it will be harder to qualify for a loan.
Part of the equation that most people ignore is what they spend their money on. With your broker being required to make reasonable enquiries into your spending, including examining bank accounts, to verify your estimates of your living expenses. While the banks will have minimums for each family situation, they want it to be adjusted upwards to match your particular situation. Where you have obligations such as insurances, pay TV and club memberships, those amounts will all need to be added on top of their minimums or your other normal living expenses.
What is "LMI"?
"LMI" is "Lenders Mortgage Insurance." This insurance doesn't protect you, it protects the lender. Many lenders will ensure all of their loans, only passing this cost to you when you’re over 80% LVR (see LVR question above). A few lenders will go up to 85% LVR without charging you for LMI, and several of the major banks will allow up to 90% LVR for certain medical professionals.
LMI costs vary according to the LVR and amount borrowed. With slight variations from one lender to another. It's not unusual for a borrower to be charged something on the order of $10,000. Part of your mortgage broker's preliminary assessment will be to provide an estimate of what the LMI charge will be for the recommended lender. Your broker should also be able to show you how the LMI varies from lender to lender in your particular situation.
Is loan interest tax deductible?
That's a great question, to answer that you’ll have to head over to GraceFinancial.com.au, our financial planning website, and learn more about tax-deductible investment expenses there.
What documentation do I need to provide to apply for a loan?
It varies slightly from bank to bank, but for PAYG income earners this would be typical:
- Your last two payslips
- Your last Notice of Assessment (Find it at MyGov - ATO) or Group Certificate (from your employe)
- ID verification with Drivers Licence & Passport or Birth Certificate + proof of change of name, if applicabe
- Medicare card
- The last six months of statements for all transaction accounts and credit cards
- Rates statements for existing properties being used as security
- The contract for properties being purchased (unsigned but with purchasers' names and purchase price)
For self-employed borrowers, generally you’ll need to have your ABN for two years, and most lenders want two years of financial reports, tax returns and Notices of Assessment too.
Business loan advice
Business finance is a complex area, and you need the sort of assistance that we provide here at Grace Loans. We have helped many small to medium business enterprises to get the funding that they have needed for expansion and operation. Give us a call today.
*Please note that this tax information is provided by James Massey, authorised representative 398841 of HNW Planning Pty Ltd, AFSL 225216. Any advice is general in nature and may not be appropriate for your specific situation.